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THE BEST that can be said for the Advisory Council on Social Security is that after two years of study, its 13 members could not agree on what to do about the allegedly ailing program. They did agree about some of the “facts,” and that agreement is enough to make one relieved they didn’t agree about much else.

Somehow they got into their heads the notion that the program’s surplus, which goes into a “trust fund” invested in long term government bonds, earns only 2.3 per cent interest. They say that rate is “adjusted for inflation,” but I have my doubts. According to the latest figures available, at the end of 1994 the fund contained $415 billion, and in 1995 it earned $31 billion. I make that out to be 7.5 per cent[1]. Taking into account the change in the Consumer Price Index (2.7 per cent), we arrive at a real return of 4.64 per cent[2] more than twice the rate assumed by the Advisory Council.

A point to notice is that there was almost no trust fund until Social Security was “reformed” in 1983. After all, the actuarial problem is not complicated. Even in the BC (before computer) era, the number of people reaching retirement age in any year could be accurately foretold, and reliable estimates could be made of those who would die or become disabled.

In such circumstances it is ridiculous and wasteful to maintain a trust fund. The businesslike thing to do with regular costs is, as the accountants say, to expense them-that is, to pay them as they become due, just as the rent and wages and interest are paid. It is prudent to put aside an amount equal to a few months’ expenses in case another nut imagines he has a contract to shut the government down. Otherwise, in a population as large as ours the risks are as level as can be, and the nation can and should be a self-insurer.

For a year the commission dithered, apparently convinced that Stockman was born for strange sights, things invisible to see. Then, as Senator Daniel Patrick Moynihan later told the story in a newsletter to his constituents, he and Senator Bob Dole put together a semisecret unofficial group to take action. “In brief,” he wrote, “in 12 days in January 1983, a half-dozen people in Washington put in place a revenue stream which is just beginning to flow and which, if we don’t blow it, will put the Federal budget back in the black, payoff the privately held government debt, jump start the savings rate, and guarantee the Social Security Trust Funds for a half century and more.”

The Senator’s circular letter was dated June 10, 1988-less than nine years ago. How did the supposedly magnificent “revenue stream” it describes dry up so quickly? Why must we find a new one now? We hear a lot about the size of the Baby Boomer generation as compared with the size of the succeeding generation. But in 1983 the Boomers were all grown up, and their children were mostly born; so there were no big demographic surprises. It is also said that the Boomers’ life expectancies are longer than those of their parents’ generation. This is certainly true, but just as certainly it should have been obvious to the architects of the 1983 solution. The World Almanaccould have told them that life expectancies in the United States have increased every year since at least 1900.

If a blue-ribbon commission somehow got it wrong in 1983, is there any reason to expect that another blue-ribbon commission, perhaps with Mr. Greenspan again as chairman and Messrs. Dole and Moynihan again as members, could get it any better in 1997?

No, there is not. The Social Security Act Amendments of 1983 set up a system of increased taxes and reduced benefits in order to build a trust fund that was expected to take care of things until 2030. Now we are being told by prophets of doom (some of whom were members of the 1983 commission) that we must do something drastic about Social Security entitlements today or the trust fund will run out in 2030, inciting an intergenerational war.

What, I wonder, is all the excitement about? The trust fund was planned to run out in 2030. If the end of the fund in 2030 is expected to signal the end of the Republic, why didn’t the 1983 commission Senator Moynihan was so proud of attend to it, instead of pushing the problem off on another generation? And why should the present generation be saddled with solving a crisis that won’t occur until long after Senator Strom Thurmond has retired? Why shouldn’t the generation of 2030 be expected to solve a problem that will occur, as they say, on its watch?

There are answers, but they’re not what you read about in the papers. The thing is, the Social Security system is what Wall Street calls a cash cow-by far the biggest cash cow, public or private, there’s ever been. Greedy men and women-exemplars of homo economicus—dream about her and can’t keep their hands off her.

Several schemes are being floated simultaneously. Some want to increase Social Security taxes to preserve and increase the trust fund. They want to do that not for any actuarial reason, but because the Social Security surplus is used to reduce the Federal deficit, and there is the possibility (remote yet real) some deficit hawk will get the shocking idea of levying progressive income taxes to control the deficit.

Since Social Security taxes are as regressive as taxes get, an increased Social Security tax is a valuable trade-off for the benefit of the rich and famous. It’s even better for them than the Forbes flat tax, because the tax starts with the first dollar anyone earns (that sticks it to the lower classes!) and ends at $65,400 instead of continuing on to tax every last megabuck reaped. In addition, it is a tax only on those who are employed and those who employ them. If you are an economic specialist and restrict your activity to clipping coupons and cashing dividend checks, you don’t pay any Social Security tax at all.

As it happens, Senator Moynihan understood the ploy in 1990 and tried to forestall it by reducing Social Security taxes and returning the system to a pay-as-you-go basis. When he couldn’t persuade his fellow Democrats to go along, he asked why we needed the Democratic Party. It was, and too often still is, a good question.

Another greedy scheme yields an additional motive for wanting the Social Security surplus to be ever larger. Brokers and investment bankers have long had their eye on the trust fund. For them it presents a charming opportunity. Think of it! Imagine your rich and doting uncle[3] turning over to you a fund of half a trillion dollars, now growing at the rate of close to $50 billion a year, and instructing you to churn the market and make it grow faster. Wouldn’t that be fun?

It would, in fact, be unadulterated fun. You wouldn’t have to weary yourself persuading tens of millions of timorous senior and pre-senior citizens to entrust their savings to you; your uncle would handle that. Nor would you have to maintain tens of millions of separate accounts and draw and mail tens of millions of checks every month, together with resolutely upbeat letters explaining why benefits are less than expected. Your uncle would handle those chores, too. A very handy and efficient fellow, that uncle, regardless of what you may hear on the radio.

MOST OF THE “reformers” put great stress on the questionable assertion that an individual citizen knows better what to do with his or her money than some faceless and indifferent bureaucrat in Washington. This tired old wheeze goes back at least to Adam Smith, whose faceless and indifferent bogeys were, Smith-quoters may be astonished to learn, not government employees, but members of the boards of directors of private corporations, some of which were remarkably similar to today’s mutual funds.

Let us try to foresee what would happen if some privatization scheme-say, investing 25 per cent of the trust fund in the stock market-should be adopted by Congress and signed by the President. Since, as we noted in “Caught in a Boom Market” (NL, September 9-23, 1996), the number of available shares is limited, the influx of something more than $125 billion would send prices shooting up. But it would have taken a while to get the “reform” bill through; consequently, much-if not all–of the rise would have been anticipated by smart money pulled out of other investments. The trust fund would not participate in the initial boom. Also, the source of the cash needed to move into the market would be a problem. The trust fund would have to redeem some of the government bonds it is holding, the Treasury would have to sell other bonds to get money to pay these off. In other words, the deficit would be increased by the amount invested in Wall Street.

Where would the money to buy the new bonds come from? All the smart money would already be in the stock market’ but perhaps there would be some timid money eager to shift from stocks to bonds, especially if the new bonds were priced low enough to yield an attractively high rate of interest. The high interest would send stocks down as more money shifted from stocks to bonds; then some would shift the other way, just as money sloshes from technology stocks one day to nursing homes the next. Where would the turmoil end? It would not end. As Ring Lardnermight have said, that would be part of its charm.

Both the stock market and the bond market are always churning, because traders are constantly evaluating and reevaluating possible investments, trying to determine their comparative future earnings, capital gains and risk. When the market is volatile, the vital question is what the various stocks and bonds are going to sell for tomorrow. In the end, this all is guesswork, even when mainframe computers spew out charts of many colors: What’s to come remains unsure.

If the stock market is now “outperforming” the bond market, it is because the stock market is considered riskier, and the claimed difference in performance is a measure of the perceived risk. The very term “social security” suggests that the program is correct in its present stance of being risk-averse.

Some claim that investing Social Security funds in the stock market would send prices even higher, and that high stock prices make it easier for new companies to be launched and old companies to be expanded. Other things being equal, as economists say, this claim may be sound enough, but there is another side to it. When the market is really soaring, it becomes much simpler to make money by speculating in stocks and bonds than by producing commodities for people to use and enjoy. Things apparently are not equal at the present time, for leading American companies seem to have more cash on hand than they know what to do with. Why else would IBM and so many others be buying back their own stock instead of investing in new or expanding enterprises?

All that would be accomplished by putting Social Security funds at risk in the stock market, it can safely be said, would be a steady upward redistribution of income and wealth. The rich would in general become richer, and the poor poorer. Try as they may, some people seem never to be near a chair when the music stops.

Stockholders and bondholders (both new and old) would, as a group, be likely to prosper about as fast as, but no faster than, the Gross Domestic Product. The only way they might have the illusion of prospering more grandly would be if inflation accelerated. Brokers and investment bankers would be the big winners in fact, taking them as a group, the only winners. The cash cow would be lavish with commissions and fees and interest on margin accounts.

The costs of moving the Social Security trust fund into the market-particularly the increased deficit and the interest bill on the new bonds-would be borne by the government. There would be a furious struggle to decide whether to increase the debt or to downsize the budget. No matter how it was resolved, those at the bottom of the income scale would be pushed lower. Almost all bonds are necessarily bought by the rich; the interest they receive is, in our present tax system, disproportionately paid by the lower middle class-the same people who typically suffer when the budget is shrunk.

It all comes down to this: Individuals can, and many do, make out like bandits on Wall Street, but society as a whole cannot be more comfortable or more secure without producing more goods and services. Whatever it is that Wall Street produces, it is good neither to feed you if you’re hungry, nor to clothe and shelter you if you’re cold, nor to heal you if you’re sick.

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I WANT TO tell you about a new book you probably will not quickly hear about elsewhere. It is not the sort of book most newspapers or magazines notice, because it is a serious work on economics and full of unfamiliar ideas. Nor is it the sort of book professional economics journals review, because it is not narrowly technical and the author is not a professional economist.

Leakage is an extraordinary achievement- a careful, probing, empirical analysis of the American macro-economy and, a fortiori, any free-market economy in the modem world. It is relevant for economic theory and turns a strong light on many dark and murky notions that are today taught in the colleges. It is also relevant for policy and hence for politics.

Powers’ argument is deceptively obvious. What he calls the Composite Producer, or the producing economy considered as a whole, pays people money for the use of their labor and their capital and their land to produce goods and services; there is, ultimately, no other source for money income. The Composite Consumer, or all the people considered as a whole, uses the money (wages, rent, interest, profit) to buy what has been produced; there is no other way the economy can recoup the costs of the goods and services that have been produced.

So far, one might think this is merely another form of Say’s law that production creates its own demand, or of its contemporary version, the supply-side delusion. But the conclusions of Say and Powers are almost diametrically contrary to each other. Say wrote: “It is the aim of good government to stimulate production and of bad government to encourage consumption.” In contrast, Powers writes: “Receipt of income from the nation [i.e., the producing economy] entails a responsibility for the spending of that income. Failure to spend income for goods and services must be seen as a transgression against the weakest and most vulnerable families of the nation.”

Powers notes that the Composite Consumer doesn’t spend all of its income, with the result that the Producer increases prices and reduces expenditures for labor and capital use. Production necessarily drops below the optimum. A freefall, however, does not ensue, because the Composite Producer is continually introducing efficiencies in production processes and creating new products.

Studying a run of the Statistical Abstract of the United States, Powers finds that in the American economy, in good years and bad, the annual cost of producing and maintaining capital goods and services is a quasi-constant, never varying much from 20 per cent of the total cost of production. This quasi-constant and several others, Powers observes, will require further analysis (one of Leakage‘s virtues is that it opens avenues for further research), for substantial reform of the economy is likely to depend on their interrelationships and on the internal organization of at least some of them.

Given present circumstances, it seems evident that aggregate investment will not be increased without increasing aggregate consumption. Thus, the supply side cry of both classical and neo classical economics; that we must curtail consumption in order to save, and that we must save in order to invest, is hopelessly wrongheaded.

Flying in the face of ascetic moralizers since the beginning of time, Powers shows that saving, or non-consuming, not only fails to boost production but actually lessens it. He writes, “When the demand for consumer goods and services is reduced, so also is the demand for capital expenditures. They are not independent variables.”

Saving-both personal saving and undistributed corporate profits-is the main example of what Powers calls “alpha leakage.” A certain amount of alpha leakage, mainly cash balances for routine transactions or as bank reserves, is unavoidable and fairly constant. Ordinary savings by some people for retirement, education and emergencies do not upset the economy, because they are roughly balanced by other people spending previous savings for the same purposes.

The rest is a consequence of maldistribution of income, whereby some people receive more money as wages or capital income from the production of goods and services than they know how to spend on them. So long as domestic (not foreign) goods and services are involved, sumptuous or extravagant expenditures are not economic leakage, but of course they may be deplored on other grounds.

In this connection, Powers makes another observation that flies in the face of conventional wisdom: Because government does not save, but spends its entire income on goods and services, taxation “cannot be a source of leakage and reduction of output.” Aggregate demand (and hence production) is increased by taxation of income that would otherwise have leaked from the economy, whereas taxation of personal or corporate income that would have been spent on goods and services has no effect on aggregate demand, though it certainly affects individual demand.

There is another type of leakage-Powers calls it “rho leakage”-that consists of money lost or denied the economy by constrictive policies of the banking system (in recent decades the Federal Reserve’s misconceived specialty), by bank failures and business bankruptcies, and by stock market crashes. (I’d add bull markets as well as bear markets; see Taking Stock of the Stock Markets,”NL, July 11, 1988.) Rho leakage is much more volatile than alpha leakage.

ANALYZING published government statistics, Powers is able to estimate what the American rate of growth might have been if there had been no leakage, what it actually was at any point since 1900, and over five year periods dating back to the end of the Civil War. You will note that Powers is concerned with the rate of growth, as befits a dynamic economy, whereas conventional economics is generally satisfied with statistics of absolute growth. Because the rate of growth is at issue, Powers gives us a whiff of elementary calculus. At this point some may want to follow the advice of the famous footnote in The General Theory where Keynes writes, “Those who (rightly) dislike algebra [and calculus] will lose little by omitting [this] section of this chapter.” In any event, Powers performs the necessary operations for us and gives the results in 48 useful tables and 32 clear, elegant graphs available nowhere else and alone worth more than the cost of the book. In this space it is possible to suggest only a few of his conclusions:

“Virtually every transient feature of economic behavior is a consequence of decisions and actions of persons in control of public economic policy.”

“Irregularities of performance are related to maldistribution of income.”

“Because they believe that the progress of the GNP over a period of several years reveals the growth capacity of the nation, economists generally underestimate the actual capacity.”

“Monetary restraint had no remedial effect on inflation; on the contrary, it always raised the price level.”

“Growth never required a relative increase of investment.”

“There is no connection between employment and monetary stability”

Deficit spending without appropriate taxation is “a way of transferring income from the general population to the wealthiest minority of it.”

The book’s final chapter is an analysis of inflation similar to that of the late Sidney Weintraub, a frequent contributor to these pages. Despite intense union activity during most of this century, the wage share of business income has not substantially changed. The reason is that struck corporations seldom give raises unless they can also raise prices. It is noticeable that the general price level increases most in years of heavy strike activity. Powers’ solution, that strikes be forbidden except for a share of dividends, is probably unconstitutional.

I must confess that Leakage has a special fascination for me because its author took up economics after retiring from an internationally recognized career as a research chemist, while I took up economics as I approached retirement from a background in literature and philosophy and a career as an executive of a small independent corporation largely concerned with the liberal arts. Despite our widely disparate backgrounds and habits of thought, we reached essentially identical positions on point after point. That these positions are, more often than not, identical to those previously taken by Keynes (whose background and habits of thought were certainly different from either of ours) is, at least for me, an additional reason for taking this original book very seriously indeed.

Leakage will prove valuable to anyone actively concerned with economics, politics or recent American history. Highly recommended, as you may have gathered.

Fisher’s prophecy is as good today as it was on the eve of the Depression. All it took to make the market go up then was an influx of money, and that is all it takes now. Per contra, without an influx of money nobody, not even the wisest professors in the land, can induce the market to levitate.

The stock exchanges are, after all, among the few remaining places where the law of supply and demand still runs according to script. Brokers, bankers and publicists who operate in the shadow of the exchanges come to feel the law obtains always and everywhere, imposing market discipline as it goes. But as anyone who has noticed the programmed gyrations of prices in malls and supermarkets knows, this is not the case.

For the law to work, supply must be limited. It no longer is limited in most transactions of daily life. When a bookstore runs out of a bestseller today, it can have fresh stock tomorrow. If you want a new automobile, there are, as my Vermont father-in-lawonce remarked, plenty of people ready to sell you one.

Supply used to be limited in isolated provincial markets of the sort familiar to Adam Smith, and it is still limited in the narrow confines of Wall Street. Only the issues of a certain number of companies, and only a certain number of shares of each, are admitted for trading on the exchanges. When millions of people with money in their fists start demanding to purchase some of the finite supply, the old law comes into play and prices go up. We have a bull market.

The 1920s upsurge was generated by what may be called exuberant greed. The Great War had liberated and greatly enlarged the middle class. Wall Street promised more liberation. Today greed is certainly just as crucial, but the mood is noticeably different, more desperate than exuberant. For a moment, it seemed like morning in America, but the Baby Boomer generation has grown up and begun to worry about its retirement years, because suddenly they bode to be less golden than those of its parents.

The problem is, at least initially, demographic. Generation X(or whatever it may ultimately be named) is substantially less numerous than its parents’ generation. It is said, therefore, that the Social Security and Medicare trust funds will be depleted, and that the burgeoning costs of these “entitlements” will fall on a smaller number of taxpayers. Much as they love their folks, the young are expected to revolt. Boomers are advised to start looking out for themselves.

Where to look is the question. Many financial advisers answer that, over the years, the stock market has out-performed all other kinds of investment – Treasury bonds, foreign currencies, real estate, collectibles, gold, pork bellies, the lot. The difficulty that few citizens are qualified to play the market seems solved by the existence of 7,000 or more mutual funds whose comparative performances are widely rated. It is unlikely there are 7,000 fund managers more qualified today than Irving Fisher was in his day, but let that pass: The 7,000 funds now manage close to $3 trillion.

Unfortunately, this astronomical sum must be multiplied many times if it is to do the job expected of it. The Boomer objective, after all, is a decent retirement income. Not to be too ambitious, let us say something around $35,000 a year, which is somewhat more than the present median family income. This will certainly not be enough if Medicare is privatized any further, or if the Social Security COLA is eliminated. Nor will it be enough if inflation continues at its current “optimal” rate of 2.5 per cent, since over 10 years this will raise the price level 31 per cent. We can’t, however, allow for every contingency, or we would give up at once.

So let’s assume $35,000 a year, and let’s assume further that Social Security will somehow be good for $10,000, leaving our typical Boomer with $25,000 a year to coax from Individual Retirement Accounts (IRAs), 401(k) schemes and other available fliers. Right now the average stock’s dividend is running at not much more than 2 per cent. At this rate, to rake in $25,000 a year in dividends, our Boomer’s portfolio would have to be worth roughly a million and a quarter.

Although I am no Irving Fisher, nor was meant to be, I think I shall not go far wrong in prophesying that the market will continue climbing, because the desperate Boomers are going to have to put their retirement money somewhere; and regardless of what Bob Dole’s new supply-side friends say, the country isn’t full of enterprises crying for new capital. As long as the Boomers’ annual contributions to IRAs and 40 1(k)s go into the market faster than other people take their money out, the weary bull is bound to keep scrabbling upward, at least for a while.

BUT ALL good things come to an end, and we have already received intimations of the mortality of this one. There are, to begin with, the worries about our corporations’ abilities to compete in the new global village, plus the uneasy suspicion that the information superhighway may turn out to be a curiosity, like the English Chunnel[1]. The principal sign of danger, however, is the 2 per cent dividend rate previously mentioned. Stocks paying only 2 per cent are an acceptable gamble as long as capital gains keep piling up. When they start falling (or turn negative), the stodgy 6 or 7 per cent yield of the Treasury long bond looks like an increasingly desirable port in what could develop into an unpleasant storm.

In 1983, when the present bull market began, the dividend yield of the Standard & Poor’s 500 was more than 6 per cent. When (post hoc and probably propter hoc) the dividend rate fell below 3 per cent, we had the “corrective crash” of 1987. Four years later, the rate had worked its way back to 4 per cent. Now, ominously, it is the lowest it has ever been.

It is by no means certain that even a 2 per cent dividend rate can last. The economy is strong enough to frighten the Federal Reserve Board, and all that, but the rate of profit has been maintained to a considerable extent by downsizing, and the thing about that is it frequently means exactly what it says. For when a company cuts staff, it cuts output, too-unless it has previously been unlucky or unbelievably inefficient or surprised by overwhelming technological change.

The trick is to cut jobs and wages faster than output. If a firm can manage that, its “productivity” will rise, though its production will probably fall. The lower cost per item produced may delight its economist and please its cost accountant; nonetheless, its total profits are likely to fall with its total output. Indeed, a company can be the most “productive” outfit in an industry (as Nissan’s and Toyota’s American automobile plants were rated last year), yet operate at a loss (as the Nissan and Toyota factories did).

For the nation all the time, and for the stock market in the medium and long run, what counts is production, not productivity. Production-goods and services created-can be used and enjoyed, and if so, can yield profits. Productivity which is merely an index number, a ratio of output to hours worked, nothing tangible – is not good to eat and pays no dividends.

The way things stand, if dividends fall much lower, capital gains will dry up as cautious money leaves stocks for bonds; the bull market will approach its end. At some point before the end, or soon after, fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect. The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate. Therefore, for the Boomer generation to enjoy a reasonably comfortable retire there will no doubt be calls for the Federal Reserve Board to intervene, and the Board will be tempted to comply. Besides wringing its hands, it will have two choices: to raise the interest rate, or to lower it. It will be leery of raising it, because someone on its staff may remember that in 1929 and 1930 the Reserve’s tight money policy was blamed for triggering the Crash and then turning it into the Depression.

In any event, raising the interest rate would lower the price of bonds; and almost immediately the price of every income-earning asset, including common shares, would follow. In other words, the stock market would fall, or at the minimum be impeded in its climb. In addition, the costs, and hence the prices, of ordinary businesses would sooner or later increase, and their sales and profits would fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect.

The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate.

Therefore, for the Boomer generation to enjoy a reasonably comfortable retirement, as every generation should, it can no longer consult its narrow self-interest. Instead, it must look forward to, and participate in, and help organize, a great surge in the gross domestic product. This can be accomplished in only one way in a free society. It is not enough for goods to be manufactured and services to be made available. To contribute to private profits and common wealth, commodities must be sold, and someone must be both willing and able to buy them. Otherwise, sensible producers will cut output and make up for the resulting drop in profits by laying off employees.

Mass industry requires mass consumption. But that will require a more generous and hopeful and responsible attitude toward the distribution of income than has been seen, in this country for many long years.

The New Leader

[1] Ed – so much for prognostication, neither turned out to be “merely a curiosity.”